Fines for Environmental Violations may be an Ordinary Cost of Business-Tell that to the Budget Committee!

Posted on February 3, 2014 by Richard Horder

Courts have long wrestled both with the survival of environmental claims in bankruptcy and with the proper prioritization of environmental claims within bankruptcy.  In Munce’s Superior Petroleum Prods. v. N.H. Dep’t of Envtl. Servs., the First Circuit split with the Third Circuit over the prioritization of punitive fines for a company’s post-petition violation of environmental laws.  In Pa. Dep’t of Envtl. Res. v. Tri-State Clinical Labs., Inc., the Third Circuit determined these to be general unsecured claims, but the First Circuit disagreed and gave the fines administrative expense priority ahead of unsecured creditors.

Tri-State Clinical Labs. involved a company that violated solid waste disposal laws by disposing of biological materials into the general trash.  The company engaged in this conduct both before and after filing for bankruptcy, and the Pennsylvania Department of Environmental Resources (DER) assessed criminal fines for both the pre- and post-petition conduct.  The parties agreed that the fines for the pre-petition violations were general unsecured claims, but DER contended the fines for the post-petition violations should be given administrative priority pursuant to 11 USCS § 503(b)(1)(A) (i.e., as “the actual, necessary costs and expenses of preserving the estate”).  The court disagreed.  First, the court looked to the specifically-itemized administrative expenses set forth in the statute, and determined, with the exception of fines related to taxes, they were all “compensation for services that are necessarily incident to the operation of a business.”  The fines, being punitive in nature, were not compensation for services, and a company’s unlawful conduct is not a “necessary cost of doing business.”   In addition, the specific inclusion of tax fines suggested Congress’ intent not to include any other type of “non-compensatory” penalties.  Finally, the end result of granting a punitive fine administrative priority status would be the payment of that fine by innocent third parties (the unsecured creditors), not the debtor.  The court contrasted its decision with a situation involving compensatory payments to the state for its work in cleaning up a contaminated site, which would have received administrative priority. 

The court in Munce’s Superior Petroleum Prods. disagreed with this analysis.  Munce’s Superior Petroleum Prods (MSPP) violated state environmental laws requiring secondary containment around its aboveground storage tanks.  The New Hampshire Department of Environmental Services (DES) filed an action in court, seeking injunctive relief and civil penalties, and the court entered a consent preliminary injunction requiring MSPP to bring its tanks up to code or take them out of service.  MSPP did not comply with the injunction, and DES filed a motion for contempt.  MSPP then filed for bankruptcy.  The state court stayed the DES action, but then lifted the stay on a finding that DES was “protecting public health and safety and the environment.”   The state court then granted DES’ motion for contempt, ordered MSPP to take its tanks out of service and fined MSPP $1000 per day of noncompliance.  MSPP still did not comply, and the court ultimately granted DES’ motion for $192,000 in fines.

The bankruptcy court assigned the $192,000 in fines administrative expense priority, and the First Circuit affirmed.  The court first determined that the fines were for post-petition conduct (not complying with the contempt order), not for the pre-petition environmental violations that originally triggered DES’ lawsuit.  Next, the court decided that “in light of today’s extensive environmental regulations, the payment of a fine for failing to comply with those regulations is a cost ordinarily incident to operation of a business.”  Therefore, “fines for noncompliance post-petition with state environmental law” fall within 11 USCS § 503(b)(1)(A) and should be granted administrative expense priority. 



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